Obsessed with the US dollar
There has long been a love-hate relationship between Asia and the US dollar. Last month, our own Monetary Authority proudly reported on progress among the region's central banks in developing an Asian bond fund, designed to encourage investment in regional currencies and wean people away from the mighty US dollar. Ten days later, however, the Monetary Authority admitted, in its annual report, to having raised the benchmark exposure to the US dollar in Hong Kong's own foreign currency reserves, which it manages, from (subject to some reading between the lines) an already high 79 per cent to 87 per cent.
Part of the US dollar allotment is justified by Hong Kong's currency board promise that the currency in circulation, plus all bills and notes issued by the Exchange Fund, shall always be backed by US dollars. But, even after allowing for that, some 82 per cent of remaining foreign exposure is assigned to the US dollar.
The target figure emerges, by and large, from feeding a set of investment objectives into a technical model. What you get out depends crucially on what you feed in. The input objectives here include maintenance of adequate liquidity, preservation of capital and of the long-term purchasing power of the assets, and, implicitly, a desire to avoid undue volatility.
How does this produce so many eggs in the US dollar basket? The explanation, and at the same time a distinct weakness of the system, lies in the fact that, although the objectives appear sound enough, performance is measured solely in terms of Hong Kong dollars. The simplest way to avoid any exchange risk would therefore be to adopt 100 per cent exposure to the Hong Kong dollar. But that would plainly make a nonsense of the concept of foreign currency reserves. So, the next best thing, given that officials cannot be seen to cast any doubt over the future of the peg, is to stick with the US dollar. It is no surprise that a high US dollar proportion then emerges.
Part of the rationale for holding foreign reserves is as insurance against unforeseeable disasters, including any calamity befalling the local currency. In that sense, we ought to pay more regard to their value in terms of global purchasing power than in terms of the Hong Kong dollar. On the global basis, last year, since the Hong Kong dollar weakened by 3 per cent on average relative to trading partners, the investment return of the Exchange Fund would have been 7 per cent rather than the published 10 per cent. In other circumstances, notably if the peg regime was ever altered, the difference between the Hong Kong dollar and global performance could be much more striking.
The decision to ratchet up US dollar exposure took effect in January last year, but with the intention to implement it gradually. In the ensuing 12 months, the US dollar actually fell 15 per cent against other currencies. I hope, for their sake, that the bankers and businessmen who sit on the Exchange Fund Advisory Committee were not too hasty in practising for their own account what they preached - or what was preached to them - in that forum. As for the Monetary Authority itself, it will have avoided some potential losses by having wisely followed the gradualist approach, with its US dollar exposure at the end of last year still 5 per cent short of the new target.
If the investment focus was shifted, more logically, towards global value, and if blind faith in the peg gave way to a more reasoned acceptance of the possibility of revisions to exchange rate arrangements in the medium term, a more balanced and intuitively sensible mix of currency exposures would doubtless be indicated. This would be more consistent, too, with that other declared objective - reducing the Asian region's fixation on the US dollar. But it would probably require some uncharacteristic activism from members of the Advisory Committee in order to initiate any rethink.
Tony Latter is a visiting professor at the University of Hong Kong
